The Online Library of Liberty

A project of Liberty Fund, Inc.

• Foreword
• Geoffrey Brennan
• Preface
• Acknowledgments
• The Power to Tax
• 1.: Taxation In Constitutional Perspective
• 1.1.: The Notion of a “constitution”
• 1.2.: The Logic of a Constitution
• 1.3.: The Means of Constitutional Constraint
• 1.4.: The Wicksellian Ideal and Majoritarian Reality
• 1.5.: The Power to Tax
• 1.6.: The Enforceability of Constitutional Contract
• 1.7.: Normative Implications
• 2.: Natural Government a Model of Leviathan
• 2.1.: Leviathan As Actuality and As Contingency
• 2.2.: Monopoly Government and Popular Sovereignty
• 2.3.: The Model of “leviathan”: Revenue Maximization
• 2.4.: The Model of Leviathan As Monolith
• 2.5.: The Constitutional Criteria
• 3.: Constraints On Base and Rate Structure *
• 3.1.: Government As Revenue Maximizer Subject to Constitutional Tax Constraints
• 3.2.: Tax-base and Tax-rate Constraints In a Simple Model
• 3.3.: One Among Many
• 3.4.: Tax Limits and Tax Reform
• Appendix: Progression In the Multiperson Setting
• 4.: The Taxation of Commodities
• 4.1.: The Conventional Wisdom
• 4.2.: Constitutional Tax Choice
• 4.3.: Alternative Forms of Commodity Tax: the Choice of Base
• 4.4.: Uniformity of Rates Over Commodities
• 4.5.: Uniformity of Rates Over Individuals
• 4.6.: Discrimination By Means of the Rate Structure
• 4.7.: Summary
• Appendix
• 5.: Taxation Through Time Income Taxes, Capital Taxes, and Public Debt
• 5.1.: Income Taxes, Capital Taxes, and Public Debt In Orthodox Public Finance
• 5.2.: The Timing of Rate Announcement
• 5.3.: Income and Capital Taxes Under Perpetual Leviathan
• 5.4: Leviathan’s Time Preference
• 5.5.: The Time Preference of the Taxpayer-citizen With Respect to Public Spending
• 5.6.: The Power to Borrow
• 5.7.: Conclusions
• 6.: Money Creation and Taxation
• 6.1.: The Power to Create Money
• 6.2.: Inflation and the Taxation of Money Balances: a “land” Analogy
• 6.3.: Inflation and the Taxation of Money Balances
• 6.4.: Inflationary Expectations Under Leviathan
• 6.5.: Inflation, Wealth Taxation, and the Durability of Money
• 6.6.: The Orthodox Discussion of Inflation As a Tax
• 6.7.: The Monetary Constitution
• 6.8.: Inflation and Income Tax Revenue
• 6.9.: Monetary Rules and Tax Rules
• 7.: The Disposition of Public Revenues *
• 7.1.: The Model
• 7.2.: Public-goods Supply Under a Pure Surplus Maximizer: Geometric Analysis
• 7.3.: The Surplus Maximizer: Algebraic Treatment
• 7.4.: The Nonsurplus Maximizer
• 7.5.: Toward a Tax Policy
• 8.: The Domain of Politics
• 8.1.: Procedural Constraints On Political Decision Making
• 8.2.: The Rule of Law: General Rules
• 8.3.: The Domain of Public Expenditures
• 8.4.: Government By Coercion
• 9.: Open Economy, Federalism, and Taxing Authority
• 9.1.: Toward a Tax Constitution For Leviathan In an Open Economy With Trade But Without Migration
• 9.2.: Tax Rules In an Open Economy With Trade and Migration
• 9.3.: Federalism As a Component of a Fiscal Constitution
• 9.4.: An Alternative Theory of Government Grants
• 9.5.: A Tax Constitution For a Federal State
• 9.6.: Conclusions
• 10.: Toward Authentic Tax Reform Prospects and Prescriptions
• 10.1.: Taxation In Constitutional Perspective
• 10.2.: Tax Reform As Tax Limits
• 10.3.: Tax-rate Limits: the Logic of Proposition 13
• 10.4.: Tax-base Constraints
• 10.5.: Aggregate Revenue and Outlay Limits: Ratio-type Proposals For Constitutional Constraint
• 10.6.: Procedural Limits: Qualified Majorities and Budget Balance
• 10.7.: Toward Authentic Tax Reform
• Epilogue

9.6.

Conclusions

The predicted intergovernmental competition for fiscal resources and the predicted mobility response of persons and resources to the exercise of governmental fiscal authority provide the relationship between the open economy and the federal political structure and, hence, the basis for this chapter’s organization. The constitutional-level choice facing the individual in a potentially open economy-open polity is significantly different from that faced in a closed system. Intergovernmental competition for fiscal resources and interjurisdictional mobility of persons in pursuit of “fiscal gains” can offer partial or possibly complete substitutes for explicit fiscal constraints on the taxing power. In prospect rather than retrospect, however, the individual cannot constitutionally ensure that his economy-polity will remain open to trade and/or migration with differing national entities. Critical dependence on “openness” of the economy seems, therefore, unlikely to characterize the rational constitutional choice of an individual.

The substitutability between intergovernmental competition for fiscal resources and explicit constitutional constraints on governmental taxing power becomes important, however, even in a closed-economy-closed-polity setting, once the possibility of federalization is introduced. Since the constitutional rules are, in this setting, presumed to remain binding, the individual may choose to rely on the indirect mobility constraints guaranteed by dispersed political-fiscal power in partial substitution for the more direct constraints that would otherwise have to be imposed. Protective-state functions would, presumably, be assigned to the central government, along with some appropriately restricted powers to tax sufficient to finance these functions. Beyond this minimal limit, however, the intergovernmental competition that a genuinely federal structure offers may be constitutionally “efficient,” regardless of the more familiar considerations of interunit spillovers examined in the orthodox theory of fiscal federalism.

The normative “theory of federalism” that emerges from our analysis differs sharply from the orthodoxy which places primary emphasis on the spatial properties of public goods. These properties become only one of several elements worthy of consideration in a constitutional choice among alternative functional assignments. And as our analysis has indicated, federalization may be efficient even when the desired public goods are estimated to be “national” in the polar Samuelsonian sense. Our emphasis is on federal assignment as a means of ensuring that individuals have available options as among the separate taxing-spending jurisdictions, and on the effect that the potential exercise of these options has on the total fiscal exploitation in the system.

In much modern policy discussion, local governments are allegedly “starved” for funds. Our analysis suggests that this situation is perhaps dictated by the competitive setting within which such governments find themselves, and, indeed, the analysis implies that this situation may well be efficient in the constitutional sense. Total government intrusion into the economy should be smaller, ceteris paribus, the greater the extent to which taxes and expenditures are decentralized, the more homogeneous are the separate units, the smaller the jurisdictions, and the lower the net locational rents.

Possibilities for collusion among separate governmental units, either explicitly organized and enforced by the units themselves or mandated by the central government, must be included in the “other things equal.” When the central government collects and administers taxes on behalf of the subordinate units, the effect is identical to explicit collusion on the part of these units. Local units should tax and spend independently. But the point here is not the traditional one to the effect that jurisdictions should be responsible for both the tax and expenditure decisions in order to ensure some proper balancing of the two sides of the account, as driven by some cost-benefit-public-choice model of electoral choice. Our point is the quite different one to the effect that tax competition among separate units rather than tax collusion is an objective to be sought in its own right. The argument is, of course, obvious when the parallel is drawn with the monopoly-competition relationship in economic theory. But notions that are obvious in one area are often neglected elsewhere, and restatement of the familiar from one setting becomes a challenge to orthodoxy in another. The modified vision of federalism that emerges here suggests, once again, the critical relationship between the normative evaluation of institutions and the political model that is employed in positive analysis.

10.

Toward Authentic Tax Reform

Prospects and Prescriptions

The analytical setting in this book is dramatically different from that which informs most of the literature of tax policy. One of our central purposes is simply to shift the grounds for discussion and debate, quite apart from any specific policy prescriptions that might subsequently emerge. Tax reform deserves to be examined in a constitutional perspective and not as some prize to be captured in a partisan political struggle over relative shares nor as some abstracted exercise within the political naiveté of the economist’s study.

In order to discuss tax reform constitutionally, however, an analytical dimension must be introduced over and beyond that within which orthodox analysis has been conducted. Comparatively speaking, it is relatively easy to discuss alternative tax instruments in a normative manner when the operation of the political-governmental process can be assumed away or put to one side, either by the partisan advocate who seeks to capture political power for his own ends or by the economist who blindly assumes government to be benevolent as well as despotic.

The constitutionalist, quite independently of his own ideological or normative predispositions, cannot even begin argument until and unless he first models the operation of government in the postconstitutional sequence. A “theory of politics,” defined as the theory of the working properties of the political process under alternative sets of rules, is logically and necessarily prior to any responsible discussion of constitutional alternatives themselves. An acknowledgment of this methodological principle confronts us with difficulties. In a very real sense, all of the public-choice theory and analysis that has been painstakingly developed over the course of three decades becomes prolegomena to analysis of constitutional design, including design for tax reform. But public-choice theory itself remains a long way from its own long-term equilibrium, potentially described by established and widely accepted paradigms.

By necessity we are required to restrict our scope and range. To do so, we have modeled politics in an admittedly extreme, and indeed simplistic, framework, one that we have called “Leviathan.” The analysis of preceding chapters has demonstrated that, given this model of government, many of the standard norms for tax reform, for idealized tax arrangements, are totally unacceptable. And by “unacceptable” we mean that the arrangements would never be selected by the rational person in a genuine constitutional choice setting where he is assumed to be empowered to choose as among alternatives for constitutional policy. It is perhaps worth noting that this conclusion of our analysis emerges directly from our positive examination of the individual’s constitutional calculus, given the model of politics that is plugged in. The conclusion does not stem from any ideological mind-set that we presume the individual to possess and certainly not from any presuppositions of our own.

Objections to the normative implications, assuming that the technical analysis holds up against possible criticisms, may properly be directed at the Leviathan model of politics. In such a sense, these objections may be at least similar in kind to those that we have ourselves advanced, in this book and elsewhere, against the benevolent despotism model that has for too long informed the orthodox analysis of tax reform. We have argued in Chapter 2 that “natural government” embodies Leviathan-like properties. There is, however, an important difference between the application and use of our model and the application and use of that model implicit in the orthodox policy discussion. In the latter, government is modeled as a benevolent despot, as an imaginary entity that can listen to, accept, and act upon the policy advice proffered by the economist. By contrast, our use of the Leviathan model of politics does not involve any offer of advice or counsel to governments. We use this model to generate predictions of a “worst-possible” sequence of outcomes, predictions that facilitate our analysis of ways and means of ensuring that such “worst-possible” results will not, in fact, be realized. In a very real sense, our whole effort is in close affinity with a Rawls-like minimax strategy.1 We should also note, at least in passing, that our whole exercise is within the spirit of the classical political economists and the American Founding Fathers, some of whom are cited at the beginning of our chapters.

Even if, operationally, our Leviathan model of politics should be wholly rejected, however, there seems to be no reasonably legitimate basis for jumping to another extreme and acquiescing in the benevolent despotism presumption. Once the latter is called into question, a constitutional approach is almost necessarily required. For example, a model of politics described by the domination of the median voter under majoritarian rules might be introduced as a substitute for our Leviathan. In this case, some of the implications for tax reform would, of course, be different from those that emerge from our analysis. But they would also, and perhaps more sharply, diverge from those that are implied from the standard treatment.

Tax reform must be analyzed constitutionally. But we need to go beyond suggestions for an approach; we need to look somewhat more directly at tax-policy alternatives as these have entered into the political discussions of the later 1970s and 1980s. Our critique, whether direct or implied, of the proposals for tax “reform” that have emerged from orthodox tax-policy discussion is sufficiently contained in earlier chapters. What these chapters have not contained is any treatment of the various proposals for constitutional change that have now surfaced to command positions of reckoned importance in current public-policy debates. Constitutional changes have been made, and many more changes are being quite actively discussed, within a realm of popular-public-political discourse that has remained isolated from the “in-house” talk of tax economists and tax lawyers. Professionals in these groups find themselves unable to articulate their own positions largely because constitutionalism is alien to their thought patterns. The so-called “taxpayers’ revolt” of the late 1970s, brought into focus by California’s Proposition 13 in June 1978, has been populist and constitutional rather than elitist and legislative in its origins. And it has taken substantial form in actual or proposed changes in constitutional rules that impose constraints on the taxing powers rather than changes in legislated tax-rate levels and tax-structure arrangements.

It should be evident that our whole analysis is directly relevant to the policy options that have been discussed in the context of the taxpayer revolution, whether real or presumed. It is, however, also important to recognize that the proposals for explicit constitutional changes in tax rules that have emerged in the course of the shift in attitudes characteristic of the late 1970s have not represented the outcome of analysis like that we have attempted in this book. As noted in the Preface, our book is two or three years late in serving this function. The taxpayer revolution has indeed been born without an analytical blueprint or even an analytical map. Nonetheless, the potential usefulness of our effort seems evident. We try to assess critically some of the proposals under popular discussion from a more sophisticated, but still constitutional, perspective than that offered by more orthodox public-finance specialists. From this assessment, our own prescriptions for authentic tax reform follow straightforwardly.

[1. ] Our use of minimax, however, seems more justifiable than that of Rawls because we are explicitly modeling the behavior of the “adversary player,” the Leviathan government, rather than “nature,” which presumably distributes talents and capacities with no malign intent.